October 6th, 2011

Solvency II’s Impact on the Reinsurance Market: Key Benefits

Posted at 1:00 AM ET

Greater Transparency and Convergence in Reporting Among Solvency II and
Equivalent Regimes

In assessing the financial security of reinsurance counterparties, cedents often struggle to reconcile disparate accounting treatments across various domiciles. Disclosure requirements under Solvency II’s Pillar Three and market consistent accounting standards will bring a high level of convergence to reports and accounts in Europe and equivalent jurisdictions. This will greatly facilitate the analysis of reinsurer financial strength.

There are some caveats, however. First and foremost, this benefit will take time to realize - perhaps up to ten years, under the phased-in implementation the European Commission (EC) suggested in its so-called Omnibus II directive. The directive constitutes a series of proposed amendments to Solvency II. The benefit may be further diluted to the extent that custom-built internal capital models diverge from the standard model defined in the Solvency II regulations. Market consistent accounting will also contribute to more volatile balance sheets and shorter underwriting cycles, once fully implemented, as noted below.

Improved Reinsurance Security Overall

As the periphery of the market is gradually brought into the center by uniform capital, governance and disclosure requirements, some reinsurers will see capital requirements increase enough to facilitate a level of controlled consolidation and capital re-allocation. This ultimately will contribute positively to the overall health of the reinsurance market.

A Stronger and Deeper Insurance Linked Securities (ILS) Market

As an often more flexible and longer-term source of capital than traditional reinsurance, the insurance-linked securities marketmay absorb some of the net benefit that larger traditional reinsurers expect to realize through Solvency II. This may work to the benefit of cedents as the capital markets compete more directly with traditional reinsurance to limit cost pressures.

While we do expect these benefits, the challenges presented by Solvency II will likely outweigh them. We discuss the key shortcomings and expected adverse effects on cedents and the reinsurance market in our next GC Capital Ideas post.

Click here to read additional stories about Solvency II in GC Capital Ideas >>

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